The importance of cash flow forecasting

Forecasting cash flow is one fundamental aspect of financial management often overlooked by business owners that can have a critical impact on the success of every business. This article from Dun & Bradstreet clearly articulates the importance of forecasting cash flow and the common issues that arise when there are shortfalls in working capital.

Cash flow is one of the key factors influencing small business survival, and the gap between when a business invoices and when it is paid can make or break an enterprise. If a business does not practice good cash flow management, it is operating at a significant risk, no matter what a business’ profit margin says. This is all the more important for SME owners in a climate of continuing global economic volatility combined with a high Australian dollar and low consumer confidence. This is reflected in the number of business failures in the September quarter of 2011, where more than 3000 businesses became insolvent according to D&B’s Business Failures and Start-ups Analysis. This represented the highest rate of insolvency during the year and indicates a poor management of business fundamentals such as cash flow.

In particular, small businesses employing fewer than 20 staff recorded the highest rate of closure- more than twice the failure rate of larger companies. Sharon Williams, founder of Taurus Marketing, has also stressed the importance of cash flow in business survival.

“Today’s economic conditions make cash flow planning even more critical to the survival, growth and profitability of business, so appropriate forward cash flow planning is a good discipline,” she told online forum Dynamic Business.

What is a cash flow forecast?

A cash flow forecast or cash budget is one tool recommended to help small businesses keep track of cash flows, and plan for periods when expenses may outweigh earnings. A cash flow forecast may assist with short-term planning, as well as enabling longer-term forecasting where businesses plan to expand.

“With little or no planning you could be forced to borrow additional funds or even have to sell up to cover debts. There is a big difference between a liquid business and one making sales,” Williams says.

The New South Wales’ government’s small business website  suggests that a cash flow forecast may be divided into three main categories:

  • Day-to-day operating activities, i.e. receipts from sales income, expenses, employee payments
  • Investment activities, i.e. purchase of plant, equipment or property
  • Financing activities, i.e. loans and repayments

How to build a cash flow forecast

Williams emphasises the importance of monitoring cash flow, and suggests that businesses have their book keepers regularly provide a number of critical documents, as follows. On a set day each month, small business owners should review:

  • Balance sheet
  • Profit and loss statements

Small business owners should monitor the following on a weekly basis:

  • Accounts receivable and payable
  • A cash flow forecast (set up as an Excel spreadsheet)
  • Purchase orders, to be filled out before expenses are incurred

Where small businesses are completing their own cash flow forecasts, Western Australia’s Small Business Development Corporation  suggests a basic layout, using an Excel spreadsheet.

  • Enter the amount of cash on hand at the start of the period which the forecast will cover.
  • Add cash inflows expected during that period, i.e. customer payments and sales, interest earnings, dividends, sponsorship and grants.
    Note that cash inflows will be influenced by the method of payment from customers, either cash or credit. Expected cash sales may be entered immediately, whereas credit sales should be entered when customers are likely to pay. This will depend on the business’s credit management policy, and ability to collect payments from customers.
    Be specific about when payments are expected or money is due for collection, and consider customers’ payment histories and the current economic outlook. Schedule the timing of payments to align with business expenses.
  • Add expected cash outflows, i.e. supplier payments, loan repayments, credit card payments, and taxes. Payments owing on Business Activity Statements (BAS) must also be taken into consideration, and should be lodged on time with the ATO to avoid incurring penalties.
    When calculating predicted expenses, consider regular, irregular and seasonal payments, i.e. rent, repairs and maintenance, and inventory purchases.

While much of this may seem self-evident, solid cash flow forecasting may prevent a small business from receiving any unwelcome surprises.

Prior warning of any liquidity problems allows businesses to find solutions to any temporary cash shortfalls, or to arrange short-term investments for temporary cash surpluses.

We regularly assist our client’s prepare cash flow forecasts and monitor working capital but we also leverage our experience to help clients improve their cash flow using a wide range of tools and techniques. The processes we have developed have been specifically tailored to reduce the complexity of managing working capital. By implementing cash flow forecasts owners are able to foresee any potential issues and plan accordingly to ensure the business continues to prosper.

Contact the Maddock’s Accounting & Advisory team here to find out how we can help.


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